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Many investors hope to become financially independent one day. That means that they wouldn’t be dependent on a job in order to pay for their everyday expenses. One way you can achieve this lofty goal is by building a solid dividend portfolio. Through this portfolio, investors will be able to receive a constant stream of dividends, effectively replacing their primary source of income.
However, building a dividend portfolio doesn’t mean investors should just look for companies that have the highest yields. There are many aspects of a stock that should be considered. In this article, I’ll discuss three of the most important aspects. I also provide examples of companies that fulfill each of these characteristics.
Dividend-growth streak
The first thing I look for in a dividend stock is a long history of increasing distributions. This is important, because it shows that the company’s management team is capable of allocating capital intelligently. One way to find companies that are capable of doing this is by looking through the list of Canadian Dividend Aristocrats. This list provides investors with all the TSX-listed companies that have managed to increase distributions for at least five consecutive years.
Fortis is an example of a company that stands out to me, in this regard. It has increased its dividend in each of the past 47 years. That gives it the second-longest active dividend-growth streak in Canada. To put this excellence into perspective, the company with the next longest dividend-growth streak comes in at 31 years. That’s more than a decade and a half shorter than Fortis’s dividend-growth streak.
Dividend-growth rate
Related to a company’s ability to raise its distribution, investors should consider how fast a company’s dividend grows. This is important to consider, because if a dividend fails to keep up with inflation, then investors will lose buying power over time. When I consider this aspect of a dividend stock, I tend to look for companies that have generated a five-year dividend-growth rate of at least 10%. In some cases, where a company has a very long history of providing a reliable dividend, I would be willing to drop this requirement to a 5% dividend-growth rate.
goeasy is an example of a company that has generated a very high dividend-growth rate. In 2014, the company paid a quarterly dividend of $0.085 per share. Currently, goeasy’s quarterly dividend stands at $0.910 per share. That represents a CAGR of about 34.5%, greatly outpacing the inflation rate.
Payout ratio
Finally, investors should consider a company’s payout ratio. Simply put, this is the proportion of a company’s earnings that are paid out as dividends. It’s important to look for companies with low payout ratios, because a low ratio indicates a safer dividend. For example, if a company encounters a period of economic uncertainty, it will have the ability to halt growth efforts and reinvestment in order to bolster its dividend. If a company doesn’t have that cash reserve from its earnings, then it will risk cutting its dividend if earnings decline for a certain period.
Despite having one of the longest dividend-growth streaks in Canada, Canadian National has maintained a very attractive dividend-payout ratio. Generally, I look for companies with a payout ratio of 50% or lower. Canadian National fulfills this requirement via its 35.7% payout ratio. This indicates to me that Canadian National should be able to continue comfortably increasing its dividend in the coming years.
The post Thinking of Building a Dividend Portfolio? Here Are 3 Things to Consider! appeared first on The Motley Fool Canada.
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Fool contributor Jed Lloren has no position in any of the stocks mentioned. The Motley Fool recommends Canadian National Railway and FORTIS INC.
